Inflation-Targeting Dead, Long Live Inflation

The Fed actually thinks it can drive 315 million souls through a 0.2% gap
in its forecasts...

Remember inflation? Central bankers do - and they want to get rid of it, writes
Adrian Ash.

Not in the way they used to get rid of it. Back then they would raise interest
rates to curb debt-fuelled spending. Whereas now they want to throw inflation
out of their policy targets instead.

The true aim being to welcome it back to the real economy.

America's zero interest rates, said the US Federal Reserve on Wednesday, "will
be appropriate at least as long as the unemployment rate remains above 6.5%." Coming
just a day after 2013's new Bank of England governor Mark Carney said he wants
to swap inflation for GDP targeting, this marks a new stage in a big and global
shift.

Yes, inflation does get a look-in. The Fed swore Wednesday that it will keep
rates at zero only so long as inflation "is projected to be no more than a
half percentage point above the Committee's 2% longer-run goal" over the next
one to two years. But that projection is of course the Fed's to make. And its
2.0% inflation target is already being fudged.

Also note - the Fed didn't say that hitting its new jobless rate will definitely
trigger a rate rise. And that 6.5% level for US
unemployment is itself an ambitious goal. Since 1948, US unemployment has
averaged 5.8%. It stood at 7.7% in November, and it has stood at or below 6.5%
in only 550 of the last 780 months.

In short, strong returns to cash savers remain a very long way off yet. Higher
inflation will meantime be tolerated - welcomed, even - as part of cutting
Western governments' huge debt burdens. Real rates of interest, after inflation,
are likely to get worse below zero. Not least because, while failing to raise
interest rates, central banks will continue to print money to buy government
bonds - thereby pushing down the interest rate they offer to other investors
(ie, you and the entire retirement savings industry).

"If Ben Bernanke thinks 4% is an appropriate level for inflation in the US," says
Jim Leaviss, blogging at UK fund giant M&G, "you wouldn't be lending money
to the government at 0.65% for the next 5 years would you?

"And with Mark Carney taking over at the Bank of England next year, market
inflation expectations [you would imagine] would be overshooting the 2% inflation
target over the next few years too?"

Put another way, "It's fairly clear, although not explicitly stated," says
the Fed chairman's sometime colleague and chum, Paul
Krugman, "that the goal of this pronouncement is to boost the economy right
now through expectations of higher inflation and stronger employment than one
might otherwise have expected."

So why would anyone hold fixed-income government debt? Abandoning all pretence
(at last) of targeting low inflation, central banks clearly want to see higher
inflation. Because in the Fed's plan - if not in reality, history or anyone
else's model since the late 1970s - the idea is that this will boost employment.
So looking ahead to 2015, the US Fed's previous dateline for any fear of a
rate hike, "Financial institutions that want to report nominal earnings, let
alone avoid real losses on portfolios that will then include $15.5 trillion
of US obligations that pay essentially zero, will be desperately reaching for
yield and risk," writes Berkeley
professor Brad DeLong. "And whatever risky assets they buy to get some
yield into their portfolios will trigger somebody to then spend more on currently-produced
goods and services.

"[So] that possible future world," says DeLong, "is not a future world in
which unemployment is still above 6.5% and forecast core inflation is still
below 2.5% per year." And yet the US Fed itself, also issuing
new forecasts after Wednesday's new policy announcement, says precisely
that. All the new policy aim has achieved, together with a fresh $45 billion
of quantitative easing each and every month from hereon, is to tweak the forecast
2015 range for US joblessness from September's guess of 6.0-6.8% to this month's
guess of 6.0-6.6%. Core US price inflation is actually forecast to fall, hitting
a 2015 range of 1.8-2.0%.

Is DeLong saying Ben Bernanke is lying? Or did he fail to check the Fed's
new predictions? Maybe the Fed is being disingenuous, ignoring the impact of
its policies on inflation so it can gain the political support needed to allow
them. Or maybe, just maybe, the fact is that the Fed - like all other central
banks today - is worse than clueless.

Frantically yanking its levers and smashing its dials, it actually imagines
it can direct the economy, now this way, now that, and drive 315 million souls
through a 0.2% gap in its forecasts. Yet instead, it risks driving the currency
over a cliff.

"At the surface level," Brad DeLong explained long ago, in a
1996 paper, the awful inflation of the 1970s happened because no one
who could "placed a high enough priority on stopping inflation." Worse still, "no
one had a mandate to do what was necessary." Beating unemployment with cheap
money was thus the only tool in the box. So by God they would use it, even
if it worked about as well as beating an egg with a shovel.

Viewed from the zenith of central-bank independence in the mid-1990s, "It
is hard to see how the Federal Reserve could have acquired a mandate [to tackle
inflation by raising rates sharply] without an unpleasant lesson like the inflation
of the 1970s," concluded DeLong in that paper.

You might think that keeping inflation low is what central banks are for.
But that's so late-20th century! And the Fed this week walked further away
from that mandate. Central banks everywhere are similarly losing their "independence" to
keep inflation in check. So guess what comes next - what must come next - before
there's any true chance of central banks hiking their rates to try and curb
your cost of living.

Formerly City correspondent for The Daily Reckoning in London and head of
editorial at the UK's leading financial advisory for private investors, Adrian
Ash is the head of research at BullionVault,
where you can buy gold
today vaulted in Zurich on $3 spreads and 0.8% dealing fees.

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